Flexibility For Adjustments and Duration

A long-lasting cartel, concerned about the fairness of the allocation of its collusive surplus must find a way to adjust its allocation of market shares when the relative situation of its members change with respect to their initial allocation. In the case of the nitrate cartels this challenge is interwined to the issue of cartel duration and the natural question of why nitrate producers could never implemented a permanent cartel.

Figure 2.6.3: Transition to Collusion in the Fourth Cartel

Notes: Vertical axis is output in tons. Horizontal axis is time. Transition Period is the time interval between the signature of the cartel contract and the start of collusion.

Table 2.6.1: Nitrate Cartels by Duration Characteristics

Cartel Initial duration Effective duration Quota-allocation Automatically

(months) (months) method (main) renewable

First 12 29 Theoretical-capacity No

Second 24 36 Time No

Third 36 19 Trial Yes

Fourth 60 60 Theoretical-capacity No

Fifth 36 36 Theoretical-capacity No

Cartel duration was explicitly agreed upon in the collusive contracts.³⁷ Table 2.6.1 presents the characteristics of the duration on the 5 nitrate cartels. Initial duration corresponds to the original duration of the agreement, effective duration is the actual time the collusion lasted, and automatically renewable refers to whether the agreement would be extended automatically and indefinitely after its initial duration had expired.

Based on this dimension of learning, we can divide nitrate cartels in two groups. The first group are the first three cartels, characterized by a slow evolution towards the establishment of a

37After the Second Cartel, a specific procedure to trigger an early dissolution of the cartel was also included in the contracts. This procedure, required the agreement of an absolute majority of producers as a fraction of industry output. Only in the case of the Third Cartel, an early dissolution was discussed and approved.

permanent cartel. Earlier cartels were emergency arrangements made in order to face transitory negative demand shocks.³⁸ In the case of the first two cartels, duration was initially set for a short period of time (1 or 2 years) under the implicit understanding that the cartel would, at the expiration date, be renewed under the same basic collusive contract if market conditions made it desirable. However, producers were tempted by the prospect of continued cooperation and the cartel contracts they signed increasingly had the perpetuation of collusion as a concern. This trend culminated in the Third Cartel contract which incorporated a clause that made its renewal automatic (in the exact same way as the contract that created the NPA automatically renewed its charter).

On the other hand, after the failure of the Third Cartel, producers never again attempted forming permanent cartels. The last two cartels were fixed-term agreements, which implied a complete renegotiation to form a “new” cartel in case that producers wanted to extend the collusive period (as it was the case when the Fourth Cartel expired) since the default situation was the resumption of competition once their terms expired .

Moreover, the cartel duration decision is linked to the question of how to implement adjustments to collusive market shares in order to keep the allocation of surplus fair. During the first three cartels the producers were looking for adjustment mechanisms that could work in the framework of a permanent cartel, which explains in part the choices they made about what quota-allocation methods they tried: Both the time and trial methods are good solutions for keeping market shares allocation dynamically fair. The time method automatically transfers market shares from plants that become relatively less efficient or lose capacity to those that become more productive or increase capacity. Relatedly, the Third Cartel contract required that plants performed periodic trials, which would generate approximate dynamic fairness in the same manner.

On the contrary, in the last two cartels instead of having a quota-allocation method that allowed for both a fair initial allocation of market shares and a dynamic adjustment as conditions evolved, the NPA could now focus only on the initial allocation leaving the adjustments for the inter-cartel period (i.e., the renegotiation of the agreement). At the same time, the diminished focus on dynamic fairness allowed the producers to reduce the incentives to invest in increased capacity, by explicitly eliminating any sort of quota increases due to investments made after the signature of

38Cruchaga (1929, p. 207) offers this interpretation for the First Cartel.

the agreement.

2.7 Final Remarks

This paper studies whether firms learn how to better organize collusion as they gain experience.

Since cartels are illegal organizations this remains an open question. To the best of our knowledge this is the first paper to be able to explore learning in relation to cartels.

To study this research question we use the case of the cartels in the Chilean nitrate industry.

Between 1884 and 1909 there were five cartels in the nitrate industry. Since collusion was not illegal in Chile at the time these cartels were completely public and their rules codified in legal contracts. Moreover, there was no meaningful technological innovation in the industry. Thus, the environment where these cartels developed was static throughout the period of study.

First, a descriptive analysis of the cartels contracts show that they grew more complex and complete during the first four cartels as producers gained experience: New clauses were incorporated that addressed issues that had mined the performance of previous cartels.

We then explore the main challenge that nitrate producers faced when organizing collusion: The allocation of collusive market shares. We describe how nitrate cartels used a total of five different methods to allocate market shares and are able to show that the additional costs caused by using two methods of special interest, the time and trial methods, were very substantial and explain why they were discarded in later cartels.

Finally, we describe how nitrate cartels were able to solve the incentive problems caused by the transition from competition to collusion and the process by which the industry converged to having periodical fixed-term agreements, instead of a permanent cartel.

Our results point to a large importance of learning in the organization of cartels. Even in an advantageous setting for collusion as the nitrate industry many of the initial solutions employed by the cartelized firms were shortsighted or sub-optimal, and only through trial and error they were able to arrive to a model contract. At the same time, this paper highlights the relevance of trade associations for cartels as a repository of relevant institutional knowledge about collusion organization.

One important extension of this paper is to explore the relation between cartel leadership and

observed distortions in the allocation of collusive surplus. Specifically, exploring whether cartel organizers received a disproportionate share of collusive surplus